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Tuesday, May 28, 2013

Uncertainty and the entrepreneur

One of Cantillon's remarkable contributions to economic thought is that he was the first to stress and analyse the entrepreneur.7 To this real-world merchant, banker and speculator, it would have been inconceivable to fall into the Ricardian, Walrasian and neoclassical trap of assuming that the market is characterized by perfect knowledge and a static world of certainty. The real-world marketplace is permeated by uncertainty, and it is the function of the businessman, the ‘undertaker’, the entrepreneur, to meet and bear that uncertainty by investing, paying expenses and then hoping for a profitable return. Profits, then, are a reward for successful forecasting, for successful uncertainty-bearing, in the process of production. The crucial Smithian–Ricardian and Walrasian (classical and neoclassical) assumption that the economy is perpetually in a state of long-run equilibrium fatally rules out the real world of uncertainty. Instead, it focuses on a never-never land of no change, and hence of perfect certainty and perfect knowledge of present and future.

Thus Cantillon divides producers in the market economy into two classes: ‘hired people’ who receive fixed wages, or fixed land rents, and entrepreneurs with non-fixed, uncertain returns. The farmer–entrepreneur bears the risk of fixed costs of production and of uncertain selling prices, while the merchant or manufacturer pays similar fixed costs and relies on an uncertain return. Except for those who only sell ‘their own labour’, business entrepreneurs must lay out monies which, after they have done so, are ‘fixed’ or given from their point of view. Since sales and selling prices are uncertain and not fixed, their business income becomes an uncertain residual.

Cantillon also sees that the pervasive uncertainty borne by the entrepreneurs is partly the consequence of a decentralized market. In a world of one monopoly owner, the owner himself decides upon prices and production, and there is little entrepreneurial uncertainty. But in the real world, the decentralized entrepreneurs face a great deal of uncertainty and must bear its risks. For Cantillon, competition and entrepreneurship go hand in hand.

As in the case of Frank Knight and the modern Austrians, Cantillon's theory of entrepreneurship focuses on his function, his role as uncertainty-bearer in the market, rather than, as in the case of Joseph Schumpeter, on facets of his personality.

Cantillon's concept also anticipates von Mises and the modern Austrians in another respect: his entrepreneur performs not a disruptive (as in Schumpeter) but an equilibrating function, that is, by successfully forecasting and investing resources in the future, the entrepreneur helps adjust and balance supply and demand in the various markets.

Professor Tarascio points out that Cantillon's pioneering insight into the pervasive uncertainty of the market was largely forgotten, and before long dropped out of economic thought until independently resurrected in the twentieth century by Knight and by such modern Austrians as Ludwig von Mises and F.A. Hayek. But, as Professor O'Mahony wryly comments: ‘To acknowledge his [Cantillon's} recognition of uncertainty when we look at him as Professor Tarascio does from a current perspective is thus more of a reflection on many modern economists whose capacity to ignore uncertainty is nothing short of bizarre than a tribute to Cantillon's prescience’.

Bizarre it may well be, but there is a method to the madness. For, as Professor O'Mahony himself understands full well, modern economics is a set of formal models and equations purporting to fully determine human behaviour, at least in the economic realm. And there is no way that uncertainty can be compressed into determinate mathematical models. As O'Mahony puts it, one might ‘ask if entrepreneurial activity can in the nature of things be made the subject of formal representations or models at all. If they could, would there be any room for uncertainty, in the true sense of the term, and, therefore, any room for entrepreneurship itself?’ Economic theory, in short, must choose between formally elegant but false and distorting mathematical models, and the ‘literary’ analysis of real human life itself.

Austrian Perspective on the History of Economic Thought (2 volume set)

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